How Do Limited Liability Companies (LLCs) Pay Taxes in USA?
Between 2004 and 2014, IRS statistics have recorded a 66% increase in the domestic Limited Liability Companies (LLC). Post it, LLC’s popularity has only increased over the years.
This is because choosing between different business entities is also dependent on the taxes that you would become liable to the government for. However, if you are here, then you are in search of more clarity in regards to LLC taxes.
A Limited Liability Company (LLC) is a type of business that is registered with the state and gives personal, limited liability protection to its owners. The owners of the LLC are known as members, and they are taxed at their personal tax rates. This is because the Internal Revenue Service (IRS) does not recognize LLCs for tax purposes.
However, the income tax paid by the LLCs depends on these two factors:
- The number of members of the LLC
- Whether LLC has opted to be recognized as a different business entity for taxation purposes
This article will take you through all that you need to know about LLC taxes, what you will be responsible for in regards to LLC taxes, and even options for reducing your LLC tax bill.
Working of LLC Taxes
For the purposes of federal income tax, LLCs are treated as pass-through entities, which means that LLCs themselves do not pay taxes on their business income. It is rather its members who pay the taxes on their share of LLC’s profits.
In addition to these federal taxes, as applicable as per the tax bracket that you are a part of, state or local governments might also impose additional LLC taxes. The LLCs’ members can, however, choose to get taxed as a corporation instead of a passed-through entity.
Combining all the LLC taxes that are levied by the federal, state, and local governments, there are several types of LLC taxes. It is the members of the LLC who are responsible for paying income tax on any income earned from the LLC in addition to their self-employment taxes.
Further on, you would also be required to pay payroll taxes and sales taxes, depending upon what you are selling and whether you have any employees or not. In fact, further complexity can be added to the fold because the LLC can decide to be taxed as a different type of business entity.
How Do LLCs Pay Income Taxes?
As an owner of an LLC, you would be responsible for the payment of a wide range of business taxes. The biggest burden in your LLC taxes would be due to the federal, state, and local income taxes.
However, how you file and pay your income taxes is dependent on whether you are the sole owner of the LLC or whether your LLC has multiple owners. Other than this, the type of business entity chosen by you would also play a determining role here.
Hence, the several types of LLC taxes that you might be responsible for are:
Income Taxes for Single-Member LLCs
An LLC that is made up of only a single owner is considered a disregarded entity by the IRS. This means that the LLC and its owner are not required to file a separate income tax in order to report its income and expenses. This is because the income and expenses of the LLC will directly become a part of the tax return of the member, i.e., you.
It would be on Form 1040, Schedule C, that you would be reporting all the business income and expenses as the sole owner of your LLC. This process is similar to the one followed by sole proprietors. You would be required to pay taxes to the IRS as per your personal income tax rate only if you have earned profit after deducting business expenses from your income. In contrast, though, if you have incurred a loss, then you would be able to subtract your business’s losses from your personal income.
Generally, this process works in the same manner at state and local levels as well. What also needs to be noted is that you will be taxed only on the income that is attributable to a particular locality or state. Your LLC will be taxed by a state on the basis of the number of sales, assets owned in that state, and payroll paid in that state.
For example, a New York LLC owned by a single member will report its business income on his/her federal personal income tax returns and state personal income tax returns. Now, if the federal income is $100 and the LLC has a $50 payroll in New York and $200 payroll everywhere, then New York would tax $25 ($50/ $200 x $100) of the income to the state.
Income Taxes for Multi-Member LLCs
LLCs that are formed of multiple members are considered as pass-through entities for the purposes of federal income tax. This hence means that just like single-member LLCs do not pay their own LLC taxes, neither do multi-member LLCs.
Instead, each member of the LLC will pay taxes in proportion to their ownership stake on the business income. The LLC tax rate will hence be determined by each individual’s applicable income tax bracket.
For example, there is a two-member LLC, with both having an ownership stake of 50-50%. In this case, each of the owners would be responsible for paying taxes on half of the business profits. Additionally, each owner would also be able to claim half of the tax credits and tax deductions that their LLC is eligible for. They will even be able to write off half of the losses incurred in the same 50-50 percent split. The taxation of a multi-member LLC is almost the same as that of a partnership.
Some of the forms that a multi-member LLC has to file with the IRS are:
- Form 1065- Form 1065 is an informational US return form on partnership income that needs to be filed with the IRS annually.
- Schedule K-1- Given to each member of the LLC, this is a summary of each of the owner’s losses, credits, income, deductions, and more. Once it is filled, each owner will have to attach their Schedule K-1 with their personal income tax return that is to be filed with the IRS.
Most of the state governments and local governments continue with pass-through taxation on LLC. However, there are some exceptions like for example, the state of California, which charges additional LLC taxes.
Opting for Corporate Tax Status For Your LLC
While pass-through taxation for single-member LLCs and multi-member LLCs is the default income tax rule for an LLC, LLCs are also given the option of choosing corporate status for taxation purposes of their LLC.
LLCs can choose to be recognized as a C-corporation or as an S-corporation for tax purposes, with the voting process and consents required for making this change is already specified in the LLC operating agreement.
By filing Form 8832 with the IRS, your LLC can agree to being taxed as a C-corporation. In addition to this IRS form, your state might require you to file some additional forms as well in order to complete changing your LLC tax status.
Once your LLC tax status has been changed to a C-corporation, you would be liable to pay 21% federal corporate tax. To file your taxes, you will have to use Form 1120, which is the US Corporation Income Tax Return form. Additionally, you will also have to pay applicable state and local corporate taxes as per where your business is located.
In contrast, if you choose to opt for the S-corporation LLC tax status, you will be required to file Form 2553 with the IRS. Similar to the LLC, an S-corporation is also a pass-through taxation entity with just a few differences in how salary and distributions from businesses are taxed. In order to file taxes for your S-corporation, you will need to file Form 1120S with the IRS, which is a US Income Tax Return form, specifically for an S-corporation.
What needs to be noted, however, is that changing your LLC’s tax status will not affect its legal standing in any way. Under the eyes of the law and all other legalities, your business will continue to operate as an LLC.
Why some do change their LLC tax status is to get more benefits in terms of deductions and credits or lesser tax liabilities. For instance, a corporation is eligible for more tax credits and tax deductions. However, this is a decision that you should not make without consulting a tax professional.
LLC Payroll Taxes
In addition to the taxes that they have to pay on their business expenses and income, LLCs that have employees also get payroll taxes added under their liable LLC taxes. LLC payroll taxes include:
- Unemployment taxes
- Social security taxes
- Medicare taxes
In order to fund the unemployment benefit programs, employers pay unemployment taxes. In the case of social security taxes and Medicare taxes, which are collectively known as FICA taxes as per the Federal Insurance Contributions Act, these are shared by the employers and employees. Hence, while giving employees their paychecks, the employers are required to withhold the employee’s share of these FICA taxes, along with the income taxes.
In order to file LLC taxes on payroll, IRS Form 940 and Form 941 are used. While IRS Form 940 is an annual form used for reporting the employer’s unemployment tax obligations, IRS Form 941 is a quarterly form. This form is used by the business to withhold income taxes and employer’s and employee’s share of FICA taxes.
What needs to be further noted about the LLC payroll taxes is that they are pay-as-you-go taxes instead of being those taxes that are paid when filing your tax forms. Considering the system of pay-as-you-go system on payroll taxes, you will be required to deposit your LLC payroll taxes across the year, but as per a set schedule by the IRS. The deposits for the same can be made on the Electronic Federal Tax Payment System (EFTPS).
Unemployment taxes are deposited quarterly, whereas medicare taxes and social security taxes are deposited either monthly or semi-weekly, depending upon the amount of your tax liability. The instructions mentioned by the IRS in their Forms 940 and 941 will help you determine the deposit schedule for the payment of your LLC payroll taxes.
The current federal tax rates for each of the LLC payroll taxes are:
Tax | Tax Rate | Who Pays | Deadline |
Unemployment Taxes | 0.6% on the first $7,000 in wages (assuming that you have paid state unemployment taxes on time and in full) | Employer | File Form 940 by January 31. Deposit taxes on the last day of the month following each quarter. |
Social Security Taxes | 12.4% on wages up to $132,900 | Employer and employee evenly split the tax | File Form 941 by the last day of the month following each quarter. Deposit taxes on a monthly or semiweekly basis. |
Medicare Taxes | 2.9% on all wages, plus a 0.9% surtax on wages over $200,000 | Employers and employees evenly split the tax. Only employees pay the surtax. | File Form 941 by the last day of the month following each quarter. Deposit taxes on a monthly or semiweekly basis. |
In addition to the federal payroll taxes, often state and local governments charge additional payroll taxes on the LLCs, hence increasing the LLC tax liabilities even more. While as an employer, you would have to pay your share of the LLC payroll taxes directly to the tax agency, in case of employee’s share in the LLC payroll taxes, you would have to ensure necessary withholding on their paychecks so that you then can remit the due payment to the state or locality.
LLC Self-Employment Taxes
Though members of an LLC are not considered as employees, under SECA (Self Employment Contributions Act), your LLC tax liabilities will also include the social security tax and Medicare taxes that you owe to the IRS. These taxes need to be paid directly to the IRS in the form of self-employment taxes. The total self-employment taxes that you owe to the IRS is 15.3% which includes the following:
- 12.4% social security tax on earnings up to $137,700
- 2.9% Medicare tax on all earnings
- 0.9% Medicare surtax on earnings over $200,000
It would be Schedule SE that will help you calculate your LLC tax liability in terms of self-employment taxes. This schedule should also be attached to your tax return form.
LLC Sales Taxes
If yours is an LLC that sells taxable goods and services, then LLC sales taxes would also become part of your LLC tax liabilities. To pay your LLC sales taxes, you will need to first collect them from your customers and then remit them to the state or the local taxing authority.
Depending on the state and locality in which your LLC is located and doing business, which goods and services are taxable would get determined. Forty-five states of the USA impose a sales tax. However, states like Alaska do not, though several cities in Alaska do impose a local sales tax.
There is a legal test for determining whether you have to collect sales tax from your customers or not. This test revolves around the concept of “Sales tax nexus,” which means the extent of connection that your business has with a state or locality. If this connection is found to be enough, then you would become obligated to collect and remit sales tax to the said state and local government.
The connection being referred to in the sales tax nexus could be in the form of:
- A physical shop in that particular area
- Employing people in that particular area
- Shipping goods in that specific area
Hence, for example, an online business can become responsible for collecting sales tax in a particular state simply because they are shipping goods in that particular state.
Most of the states follow destination-based tax rules, which means that the sales tax rate is connected with the final delivery location of the product or service. However, there are also some states which follow origin-based tax rules, in which case the sales tax rate is connected to the location of the business that has sold the said goods or services. To know and confirm the rules that apply to your LLC, you should check it with the revenue department.
LLC Taxes on Rental Real Estate Income
If you are a member of an LLC that is earning supplemental income from rental real estate or royalties owned by your LLC, then you would need to use Schedule E for Form 1040 instead of Schedule C for reporting your supplemental income. These will be taxed as per your tax bracket.
LLC Tax Forms and LLC Tax Deadlines
The exact LLC tax forms that you will be needing to file your LLC tax returns and fulfilling all your LLC tax liabilities are dependent on the following three factors:
- Are you a single-member LLC or a multi-member LLC?
- Have you chosen the default pass-through tax status for your LLC? Or have you chosen the corporate tax status for your LLC?
- Does your LLC have employees or not?
Some of the most commonly used LLC tax forms along with their deadlines are:
Tax Form | When to Use | IRS Filing Deadline |
Schedule C | A single-member LLC reports all business income and losses on a Schedule C | April 15 (attach Schedule C to your Form 1040 or personal income tax return) |
Form 1065 | Multi-member LLCs must file this tax return for informational purposes (i.e., no payment is sent with this return) | March 15 |
Schedule K-1 | Multi-member LLCs must issue this form to each member, outlining the member’s share of the LLC’s profits, losses, credits and deductions | Provide to each owner by March 15 (they will attach its copy to their personal tax return) |
Form 8832 | File this form to elect C-corporation tax status for your LLC | The new tax status cannot start more than 75 days before filing, or more than one year after filing. |
Form 2553 | File this form to elect S-corporation tax status for your LLC | Two months and 15 days after the start of the tax year in which you want the election to take effect. |
Form 1120 | Corporate income tax return for LLCs that opt to be taxed as a C-corporation | April 15 |
Form 1120S | Informational tax return for LLCs that opt to be taxed as an S-corporation | March 15 |
Form 940 | File this form to report and pay federal unemployment taxes | January 31 (you get an extra 10 days if you have deposited all your unemployment taxes on time) |
Form 941 | File this form to report the income taxes withheld from employees’ wages, as well as the employer and employee’s share of social security and medicare taxes | April 30, July 31, October 31 and January 31 |
However, you should keep in mind that if any LLC tax or LLC tax form deadlines falls on a Saturday, Sunday, or on a federal holiday, then the document can be filed on the next business day.
In fact, you can even get an extension of 6 months for your LLC tax filing if you request for the same. For instance, if you have requested for an extension on Form 1065, then your deadline would get extended till 15th September.
In order to request an extension, you will need to use Form 4868 if yours is a single-member LLC taxed as a disregarded entity. For all the other cases, however, you will have to use Form 7004 for requesting an extension on LLC tax filing.
LLC Tax Tips for Business Owners
As an LLC business owner, you have experienced feeling overwhelmed by all the LLC taxes and responsibilities that come with it. Some of the ways by which you can manage your LLC tax-related workplace stress, lower your LLC tax burden and even make your LLC tax filing easier are:
- Take advantage of any and every tax deduction and tax credit that your LLC might be eligible for. This will greatly reduce your LLC tax liability. For example, start-up costs, automobile and travel expenses, equipment costs, advertising and promotion costs, and so on.
- As an LLC owner, you might also be eligible for the new income tax deduction established by the Tax Cuts and Jobs Acts for the pass-through entities from 2018. The owner of a pass-through entity, including a single and multi-member LLC business, can deduct 20% of their entity’s net income for income tax purposes. Hence, for example, if the net income of a single-member LLC business is $100,000, then the owner may be able to deduct up to $20,000 from his or her income taxes.
- However, if your LLC taxable income is more than the annual threshold, then your deduction would be limited to 50% of the amount paid to employees of the entity, or 25% of employee payments plus 2.5% of the value of the depreciable business property. In fact, this deduction is also phased out for LLC taxpayers involved in various types of service businesses. However, LLCs who have opted to be taxed as a C-corporation are not eligible for this deduction.
- Review your LLC tax deadlines in advance and keep track of all the relevant deadlines.
- Hire a bookkeeper and a certified public accountant or a tax professional to help you with LLC tax filing.
- Discuss all the potential benefits of choosing corporation tax status for your LLC with your CPA or tax professional.
- Have a clear understanding of your state government’s and local government’s tax requirements.
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Deskera Books will ensure that your LLC tax liabilities are always calculated correctly, which will put you far from unwanted attention from the taxation authorities.
Key Takeaways
As an owner as well as a member of an LLC, there are several types of LLC taxes that you may become responsible for. The LLC taxes that you become liable for depends on the taxation entity that you choose for your LLC, the number of members in your LLC, and the state and locality in which you are based.
LLC taxes, with all their overlappings and complexities, can easily lead to chaos and tax default, and the only way you can prevent that is by being planned and organized. You should also ensure that your bookkeeping, accounting, and auditing are done efficiently. This will also lead to you filling the right forms and paying the correct amount of LLC taxes by their deadline.
In case, however, if you need an extension for filing your LLC taxes, then you should apply for the same. This will help you in avoiding any penalties that you would have to pay had you missed the deadline.
With a correct team handling your LLC taxes, you should then focus on your business and its customers such that you can improve not only your cash flow and revenue but also get positive customer feedback, improved customer retention, increased customer loyalty, and ultimately higher number of returning customers.